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5 CREDIT BUBBLE
BULLETIN Not so benign
neglect By Doug Noland
$317bn during the past year, or
18.8%. Federal Reserve Credit last week declined
$3.3bn to $858.3bn. Fed Credit has increased
$6.1bn y-t-d and $27.2bn over the past year
(3.3%).
International reserve assets
(excluding gold) - as accumulated by Bloomberg’s
Alex Tanzi – were up $1.050 TN y-t-d (28%
annualized) and $1.189 TN year-over-year (25.4%)
to a record
$5.861 TN.
Credit
Market Dislocation Watch October 10 –
Financial Times (Saskia Scholtes): “Banks and
investors are still struggling to value mortgage
securities backed by subprime home loans more than
four months after valuation disputes came to
light… The problems forced several hedge funds to
the brink…and others to suspend investor
withdrawals because they were unable to properly
value their portfolios. The latest of these is
Ellington Management Group, a $5.2bn debt-focused
hedge fund, which said in a letter to clients…that
it was temporarily suspending withdrawals from two
of its funds because of valuation problems in the
market for complex mortgage securities. The move
underscores how the riskiest tier of the mortgage
market remains illiquid, even as more normal
conditions return to most other asset classes.
Mike Vranos, chief executive at Ellington, wrote:
‘There has recently been little or no trading in
certain lower-rated or unrated subprime mortgage
securities. As a result, enormously wide spreads
have developed between bids and offers on many of
these securities.’ In a letter to clients last
week, John Devaney, chief executive of United
Capital Markets, a troubled broker-dealer and
hedge fund manager in the asset-backed securities
market, said: ‘Liquidity is horrible and prices
are in the range of five to 50 points apart
sometimes just hours or days apart.’ Mr Devaney
added that the existence of the nascent
derivatives market for such securities, in the
form of the ABX index, had exacerbated the
sell-off and uncertainty over true valuations.
‘The CDS market and its size has contributed
greatly to the volatility. As prices dropped,
there were – and still are – those forced to sell,
taking off leverage.’ Mr Vranos at Ellington said
the situation meant there was ‘no way to determine
net asset values that would be fair both to
investors redeeming from these funds and to
investors remaining in these funds’.
October 8 – Financial Times (James
Mackintosh and Saskia Scholtes): “Investment banks
are creating discounted securities to help them
clear out billions of dollars of assets they had
been holding for complex structured credit deals
cancelled during the summer credit squeeze. Last
week, Deutsche Bank sold at a discount and for
half its usual fee a $2bn collateralised loan
obligation (CLO) – a bundle of differently-rated
securities backed by a portfolio of loans… The
deals help remove an overhang of loans in bank
warehouses that has contributed to depressed loan
prices as banks have been forced to liquidate CLO
deals lacking buyers… The CLO market suffered a
virtual buyers’ strike over the summer as
investors recoiled from all complex structured
credit products.”
October 8 – Financial
Times (Deborah Brewster): “Vanguard, one of the
world’s biggest fund managers, says it was caught
off-guard by the impact of the turmoil in the
credit markets on its $25bn in quantitative
investments, and believes such strategies will be
more volatile than it first thought… Quantitative
strategies have produced outstanding returns in
recent years, but many ‘quants’ were hit badly
this summer as the turmoil that began in the US
mortgage market spread to other parts of the
financial system… An estimated $500bn is in
quantitative funds. The notional value of money
quantitatively managed is probably $1,000bn, if
leverage is taken into account.”
October
12 – Financial Times (Michael Mackenzie and Saskia
Scholtes): “Interbank lending rates in short-term
money markets, benchmarked by the London Interbank
Offered Rate (Libor), have eased since the height
of the summer credit squeeze but remain at
elevated levels. Problems are most apparent at
three-month maturities, with banks reluctant to
lend to each other amid uncertainty about their
funding needs and whether they will be forced to
make good ailing commercial paper programmes and
other commitments. ‘Libor is like a car’s oil
warning light,’ said David Darst, chief investment
strategist at Morgan Stanley. ‘It is on, but it
doesn’t tell us whether we need half a quart of
oil or the engine is about to seize up.’”
October 12 – Financial Times (Gillian
Tett): “Seven months ago, the Bank of England
issued a strikingly prescient warning about ‘value
at risk’ (VAR) models. While these models have
become endemic in the financial world in recent
years, they have a nasty habit of being
self-reinforcing, or so the Bank observes. When
volatility is low in the markets - as it has been
during most of this decade, when VAR models have
flourished - these tools typically offer a very
flattering picture of risk-taking. That prompts
banks to take more risk, which reduces market
volatility further as more cash chases assets… One
big investment bank has recently analysed the
impact of its own recent asset sales. These
suggest that, while these sales should have cut
VAR by half in recent weeks on constant volatility
levels, in practice this gain was more than wiped
out by ensuing market price swings. By scurrying
to reduce risk, in other words, the banks may end
up simply running to stand still. This problem
will undoubtedly leave many observers to conclude
that there are flaws in the VAR concept. Behind
the scenes, that is precisely what many risk
experts now privately say.”
October 12 –
The Wall Street Journal (Susan Pulliam, Randall
Smith and Michael Siconolfi): “Since the invention
of the ticker tape 140 years ago, America has been
able to boast of having the world's most
transparent financial markets. The tape and its
electronic descendants ensured that crystal-clear
prices for stocks and many other securities were
readily available to everyone, encouraging
millions to entrust their money to the markets.
These days, after a decade of frantic growth in
mortgage-backed securities and other complex
investments traded off exchanges, that clarity is
gone. Large parts of American financial markets
have become a hall of mirrors.”
October 9
– Financial Times (Ben Hall and Tony Barber): “The
French government last night stepped up its drive
for tighter financial regulation in the wake of
summer’s market turmoil, proposing a set of
controls on securitisation and bank liquidity that
go substantially further than EU calls for greater
transparency. …Christine Lagarde, French finance
minister, calls for securitisation to be subject
to a ‘degree of standardisation’, so that there is
effectively a limit on the complexity of credit
instruments. She also wants tighter regulation of
off-balance sheet special investment vehicles and
of the ‘originate and distribute’ model of credit…
‘Unregulated entities’ involved in such operations
should be subject to the same regulatory
supervision as banks, she writes.”
Currency Watch October 13 –
Shanghai Daily: “China’s foreign exchange reserves
reached US$1.43 trillion at the end of September,
up 45% from the same period last year, the
People's Bank of China said… Over the first nine
months, US$367.3 billion was added to the
country's cache of foreign exchange reserves… The
massive forex reserves are causing excess
liquidity in China. At the end of September,
China's M2…grew 18.45% from a year ago to 39.31
trillion yuan (US$5.23 TN).”
The dollar
index was down slightly this week to 78.12. For
the week on the upside, the New Zealand dollar
increased 1.9%, the Swedish krona 1.7%, the South
African rand 1.1%, the Canadian dollar 1.5%, the
Australian dollar 1.2%, the Norwegian krone 0.8%,
the Euro 0.9%, and the Danish krone 0.9%. On the
downside, the South Korean won declined 0.2%, the
Japanese yen 0.2%, and the British pound was
unchanged.
Commodities
Watch October 8 – AFP: “China’s net imports
of crude oil rose 18.1% in the first eight months
of the year as the booming country’s voracious
energy demands continued to grow, state media
reported… Net imports reached 108.2 million tonnes
from January to August, Xinhua news agency said,
quoting figures from the General Administration of
Customs… It has been a net importer of oil since
1993 and imported 138.8 million tonnes of crude in
2006, up 16.9% from the previous year. Imports
last year accounted for 47% of the country’s
overall consumption…”
October 10 –
Bloomberg (Winnie Zhu): “Saudi Aramco plans to
increase oil exports to China by at least 9% this
year to meet rising demand from refiners in the
world’s fastest-growing major economy, said two
company officials.”
October 10 – Financial
Times (Javier Blas and Chris Flood): “Codelco, the
world’s largest copper producer, yesterday said
the
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